What Will it Take for Gold
to Overcome $1000?
Boris Sobolev
Jul 20, 2009
In our articles and our newsletters
we regularly highlight gold's solid fundamentals.
- World financial/economic crisis
may have culminated and greatest risks have been averted but
it is still very far from over
- US dollar continues in its
multi-year downtrend
- World governments are committed
to issue huge volume of government debt for many years to come
- Quantitative easing - debt
monetization - is becoming a routine practice of the Fed
- President Obama's plans for
government spending are making Bush deficits seem like child's
play
The list goes on and on. Most
of gold bugs' economic projections made years ago have come true,
but gold has been stuck at a seemingly impregnable level of $1000
for almost 18 months. Will this level be overcome and when?
In our view, the current economic
situation has three different outcomes:
1. Reflationary policies of the Fed and the government
will return the economy to real growth of over 2.5%. The Fed
will be able to pinpoint the exact moment of when monetary tightening
will need to take place and carefully begin raising short term
rates, sell government bonds and agencies' notes. Perfect, precise
and proactive monetary policy will ensure price stability and
relieve the threat of escalation in inflation.
In this scenario, a V-shaped
recovery declared by the bulls will become reality. Stock market
will soar and gold, after an initial attempt to rally, will likely
fall below $700 per ounce.
2. In a huge deleveraging cycle, deflationary
forces experienced by the banks, businesses and consumers will
continue to prevail for the next several years. World economy
will largely remain in a state of stagnation, Japanese style.
Pockets of growth in the world will be insufficient to turn the
rest of the world economy around.
In this scenario, it is likely
that gold will remain in a wide trading range - $700 to $1000.
Stock market will fall below the current bear market low targeting
400-500 on the S&P 500. Gold will grow in real terms (Gold
against the S&P 500) but not in nominal terms. Profits will
be good for existing low-cost gold
producers but it will, nevertheless, be a tough environment
for PM investors.
3. Central banks and governments will continue
to inject borrowed money into the unhealthy and unproductive
sectors of the economy. This will undoubtedly lead to an increased
role of lobbyism and a diminished role of the private sector
and market competition - the main forces of capitalism. The result
is easily predictable: very low economic growth for an extended
period of time.
Rising government debt and
falling tax receipts, the growing role of the government and
increased regulation will make political pressure on the Fed
inevitable and overwhelming. Debt monetization, a crucial but
only a 'temporary' measure, will become an overused practice.
Consequences of such a monetary
policy will be downward pressure on the US dollar, inevitable
rise in inflation expectations and an upward pressure on long
term yields with growing concerns for fiscal sustainability.
With such an outcome of events,
the stock market will remain at a depressed level, but the price
of real assets - energy, food, metals - will rise. The main beneficiary
will clearly be gold, which will begin a new phase of its bull
market.
While all of the three scenarios
are possible, in our view, the probability of the first is close
to a likelihood of an economic miracle. In the near future, we
see either the second or third scenario evolving (this is in
general terms as it is never possible to predict an exact path
of an economy).
In the context of elevated
unemployment, the Administration and the US Congress (which is
starting to eye the 2010 elections), cannot allow themselves
to stop stimulating the economy, cut spending and significantly
raise taxes. Any attempt by the Fed to begin exiting its monetary
easing strategy will prompt a renewed recession. All the talk
of "exit strategy" will end as quickly as the stock
market rally, prompting another deflation scare. As VP Joe Biden
candidly stated: "We have to go spend money to keep from
going bankrupt." That is why we believe that the third
scenario is the most probable outcome for the US economy in the
next few years.
The main question is when will
inflationary expectations begin to rise causing a new stage of
a gold bull market? The best answer we can give is as follows:
The lag between monetary expansion
and price inflation in the United States is about 3.5 years.
The Fed started bloating its balance sheet about a year ago.
Therefore, price inflation could really begin showing its teeth
toward 2012. However, inflation expectations are a different
animal. In the context of a major concern for fiscal sustainability
and a prolonged period of elevated money supply by the Fed, inflation
expectations can explode much earlier. It is quite possible that
this could happen as early as next year.
If gold matches the inflationary
spike of the 1970s, then its prices should easily rise toward
$2,000.
Jul 20, 2009
Boris Sobolev
Denver, Colorado
email: Contact@ResourceStockGuide.com
website: www.ResourceStockGuide.com
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